The Lawyer’s Practical Guide to: Smart Contracts
As a lawyer, you probably hear a lot about new technologies, but don’t have time to sit and read through pages of technical information to understand if or when they’ll be relevant to your practice.
In this series, we will cover some of the major technical innovations within the legal industry from a lawyer’s perspective. We’ll tell you not just how they work, but the implications for practicing lawyers now and in the future.
First up: smart contracts.
Blockchain – The Basis of Smart Contracts
As a very brief explanation, blockchain is a distributed ledger in which all parties in a network have access to the ledger. As data is centralised and available to all, a ‘middleman’ is no longer needed.
A blockchain is set up to work on an ‘If-Then’ automated process. For example, if someone requests to transfer a bitcoin, then the ledger automatically updates to record one less bitcoin in the giver’s account, and one more in the receiver’s. Blockchain is designed so that these actions cannot be tampered with or halted once begun. This is what keeps blockchain and digital currencies theoretically secure from fraud.
If you want a more detailed understanding of blockchain, our favourite explanation is here.
Blockchain and Smart Contracts
A smart contract is a contract executed on a blockchain, or distributed ledger.
A payment in cryptocurrency would be made to receive a template contract, and would then be available to all parties. Parties can update the contract by mutual agreement before it is executed, and changes would be reflected on the distributed ledger.
Then, once the contract has been agreed, the idea of ‘automatic actions’ can be used to enforce the contract (for actions taken online). For example, with an apartment rental a digital key could be released in exchange for the deposit and first month’s rent. The ledger would record that if a payment is made by ‘x’ date, the key will be released on ‘x’ date. If the renter pays the deposit three weeks early and the owner or renter then changes their mind, it is not possible to refund the money and end the contract. The ‘if-then’ clause has been triggered and will happen regardless of other factors, so the key will be delivered regardless of either party’s wishes.
The Opportunities with Smart Contracts
When working correctly, smart contracts offer the chance to cut out the ‘middleman’, or lawyer for repetitive transactions.
A lawyer would prepare a series of template contracts, which would then be bought by the parties concerned with no direct involvement by the lawyer.
As the contracts are automatically enforced, there should theoretically be no need for litigation surrounding missed expectations.
This should remove the need for direct lawyer involvement in many common transactions, and therefore theoretically cause a dramatic shift in the legal industry.
The Issues with Smart Contracts
The issues with smart contracts are primarily around its digital nature, and the ‘If-Then’ model when it comes to real life situations.
The first issue is that as with all coded software, bugs can get into the code and cause unexpected problems.
The second issue is limitations based around the nature of these contracts. For a start, cryptocurrencies are currently required as the payment method. These are notoriously volatile, and even if legal firms and corporations begin to use them, lawyers dealing with consumers may struggle with widespread adoption.
In additional, the automatic enforcing of ‘If-Then’ digital clauses of the contract can create issues when real life dynamics come into play.
There are times when a party would want to stop a contract – for example, if they found out that the builder they had hired lied about the amount of work that needed doing and had dramatically overcharged. The contract continues to perform regardless of this new information. It cannot be rescinded in court or anywhere else.
Equally, there could also be times when a contract should be changed, due to evolving circumstances. For example, if payments were conditional on achieving milestones on time with financial penalties for late work, and then the scope changed. Both parties could agree to extend the deadline, but payments are automatically made based on the original contract terms – so cannot be amended. Parties would have to agree to make payments on the timescale of the contract, before work is completed, or create an additional agreement outside of the contract, to pay any monies deducted by the contract’s automated payments system.
Finally, there could be times when a mistake has been made in the original contract, but not noticed before execution. Both parties know the contract is incorrect but are powerless to change it. This may also necessitate in additional contracts being made to correct actions being made by the first contract.
Smart contracts make things simpler and cheaper when everybody agrees, and the contractual terms proceed as planned. When there are issues, however, its strength becomes its weakness. Whilst this problem remains, even when adopted smart contracts are unlikely to remove the need for lawyers – instead of drafting contracts, lawyers could find themselves negotiating additional agreements and workarounds for when smart contracts are not working for the parties within them. It would be ironic if those additional agreements were also executed via smart contract!
What This Means for Lawyers
The issues inherent within the ‘smart contract’ model mean that it will probably by implemented in non-legal contract type situations a long time before they are allowed as legal and upheld in courts.
For example, supply chains could benefit from this ‘smart contract’ model, as delivery of an item can automatically trigger the item to be re-made or re-ordered much higher up the supply chain, even when multiple companies are involved. If an item is incorrectly ordered, then the implications are relatively minimal.
For legal, the implications of a contract improperly executed and impossible to stop are much more significant. It will therefore be years before smart contracts are viable for legal professionals and accepted by governments. It will probably be even longer before they are adopted widely enough to create a critical mass and affect a lawyer’s workload every day. It is therefore something that lawyers should have on their radar, but not be immediately concerned about.
One thing to note, however, is that whilst it is the enterprise firms that will probably have the budgets to explore this technology first, it may be smaller firms whose caseloads are more immediately impacted. Smart contracts work best for repetitive contracts such as housing contracts, where a template is widely followed with few customisations. Work of this nature is often handled by small, local firms who would be significantly impacted if smart contracts took a percentage of their business. Firms working on complex B2B contracts, and on litigation, will probably be affected much later. Whilst smart contracts are supposed to remove at least a portion of the need for litigation, we suspect that governments will have to find a way to litigate around them when people are unhappy, and so lawyers and their clients will continue to have their day in court.
